Friday, August 9, 2013

How will stocks react to less liquidity?

Much
of the 2009-2013 stock market recovery was due to the stimulus provided by the
Fed, so it’s only natural that investors wonder if the eventual withdrawal of
that stimulus – possibly later this fall – will lead to a retreat in stock prices.

Interestingly,
the market isn’t as panicked this time around as it was in May when it was
first suggested that QE3 would soon be winding down. It’s possible that investors are becoming
inured to this suggestion, yet a more likely explanation is that they simply
don’t believe it. After all, they were
told this spring that QE3’s days were numbered only to hear the Fed backtrack
and change its mind. My guess is that
until they see that a wind down of the stimulus is imminent, investors will
remain skeptical.

By
the time the tapering finally begins, however, it’s entirely possible the
market will have already undergone a prolonged topping process. Usually before the major indices make a final
top the market spends several weeks-to-months topping out internally, that is,
a few industry groups begin declining even as the leading industry groups
continue advancing. This process could
already be underway as suggested by the dominant intermediate-term internal
momentum indicator shown here.

While
most growth-type stocks haven’t topped out yet, the market is showing
considerably more internal weakness when viewed from the standpoint of the
commodity-related industries, homebuilders and REITs, and of course China
ADRs. [Excerpted from the Aug. 7 issue of MSR]